Market Economics | Interest Rate Strategy - BNP PARIBAS ...

US: Setup for Auctions with Spread Curve Flatteners
• In general, 2y Tsy tends to cheapen relative
to the long end going into the auction and
reverse direction post auction (2s10s, 2s30s
flatteners followed by steepeners).
• 5y and 7y notes have a tendency to move
almost in line with the long end going into the
auctions and to richen relative to the long end
post auctions (5s10s, 5s30s steepeners).
• There is a clear trend of belly spread
widening relative to the front end and long end
spreads throughout the auction.
• STRATEGY: Consider paying 5y spreads vs
10y spreads. Also consider paying 5y spreads
vs 2y and 10y spreads for a higher average
move which comes with higher volatility.
With 2y, 5y and 7y auctions taking place next week,
we highlight auction-based systematic trades which
we have been recommending in the past issues of
our weekly publication.
While doing this analysis, we look at auctions since
Jan 2010 (total of 12 auctions) and keep the issues
fixed through each auction (i.e. always use the
current issue pre auction which becomes old
post auction) so that there is no spurious roll
effect.
Outright treasury curve behaviour around
auctions
Chart 1 shows that, while the front end cheapens
relative to the long end going into the auctions, the
belly moves more or less along with the long end.
Post auctions, while both the front end and belly
richen relative to the long end, a more pronounced
steepening effect is seen in 5s10s and 5s30s Tsy
curve.
Chart 1: Treasury Yield Trends Around 2y, 5y
and 7y Auction days
8
7
6
5
4
3
2
1
0
(1)
(2)
(3)
2s10s
2s30s
5s10s
5s30s
7s10s
7s30s
T-5 T-3 T-1 T T+1 T+3 T+5
Source: BNP Paribas
Chart 2: Spread-of-Spreads Trends Around 2y,
5y and 7y Auction Days
2
1
0
(1)
(2)
(3)
(4)
T-5 T-3 T-1 T T+1 T+3 T+5
2s10s
2s30s
5s10s
5s30s
7s10s
7s30s
Source: BNP Paribas
Chart 3: Comparison of 5s10s Spread Flattener
with 2s5s10s Spread Fly
10
8
5s10s
2s5s10s
Table 1 (at the end of this article) helps us put some
numbers in perspective for the above-mentioned
curve trades. 5s10s Tsy curve steepener has turned
in a profit 10 times in the past 12 auctions. The
average movement in favour of this strategy has
been about 5.2bp with a volatility of 3.8bp.
6
4
2
Sharpe Ratio
for 5s10s:
1.82
Sharpe Ratio
for 2s5s10s:
1.64
Disclosure: Given our existing structural Tsy 5s10s
flattening view initiated at 138.5, now at 139.5, we
will choose not to put on a tactical steepener but may
use any potential steepening as an opportunity to
increase our flattening position.
0
Jan
Feb
Mar
Source: BNP Paribas
Apr
May
June
July
Aug
Sept
Oct
Nov
Dec
Rohit Garg 20 January 2011
Market Mover, Non-Objective Research Section
34
www.GlobalMarkets.bnpparibas.com